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01/31/2010

Subsidies to Small Business? Becker

President Obama, in his State of the Union Address last
week, indicated that he would assist small business, particularly to encourage
their hiring of additional workers. Two days later he proposed a $33 billion
tax credit to small businesses that increase their hiring. I consider small and
medium size business the backbone of any dynamic economy, so I sympathize with
the President’s desire to encourage these businesses. However, his proposal is
not a good way to do this.

Obama’s aims are laudable: to
simultaneously increase employment, reduce unemployment, and encourage the
expansion of small and medium sized businesses. Yet, as an
employment-increasing plan, the President’s approach has many problems, and is
likely to have only limited impact. This is partly because while $33 billion is
a lot of money, it is less than ¼ of one percent of American GDP. Yet even a
much larger sum would have a small impact on employment. One reason is that the
subsidy proposal gives small business some incentive to fire some employees,
and then later to replace them with unemployed workers for whom they can
collect the subsidy.

The unemployed hired under
the subsidy program would likely receive higher pay than they would get
otherwise because companies compete for these workers to qualify for the
subsidy. Some workers might then remain unemployed rather than accept jobs in
order to get the higher pay after the program is implemented. Employed workers
at small (and even large) businesses might quite their jobs and become
unemployed in order to become subsequently employed at other small companies in
order to become eligible for any higher wages received by new hires. The
President is aware that efforts will be made to game the proposal, and he
proposed various safeguards. However, new ways will be discovered to
get around the restrictions that would reduce the net job creating potential. Further efforts to close loopholes
would lead the government to become more and more involved in the employment
decisions of companies.

Smaller businesses are an
important source of innovation and progress. Businesses like Microsoft,
Wal-Mart, Apple, Google, and many others introduced game-changing innovations
when they were very small that enabled them to grow very large, and they raised
overall productivity. This is why it is so important to promote startups and
other smaller businesses in an efficient and effective way. An effective
approach has several components, and overall the US looks quite good compared
to other countries. According to World Bank estimates, the US ranks 8th
out of the more than 180 countries they consider on their overall index of the
ease of starting a business, whereas, for example, Italy ranks 78th,
and China 89th. On the other hand, the US ranks only 25th
on the ease of getting construction permits, and 61st on taxes.

The US is tied for first
place on the ease of employing workers. It is much easier for American small
and medium size business to reduce their employment during bad times than it is
for similar-sized companies in Europe, Latin America, or India. This helps
explain why employment fell, and unemployment rose, more sharply during this
recent recession in the US than in say Germany, Italy, and many other countries
that have much less flexible labor markets, even when other countries
experienced larger recession-induced falls in GDP.

Unfortunately, several
proposals in Congress, and others mentioned by the President, would make it
less attractive to start a business, or expand a smaller business. Although it
is especially unclear after the election of a Republican senator from
Massachusetts what any final health care bill will contain, some of the
proposals would require all companies, with few exceptions, to provide health
insurance for their employees. The fact that many small businesses do not now
give their employees health insurance indicates that such a requirement would
raise their costs, and reduce their employment.

Small and medium sized
business owners are sensitive to capital gains taxes, increased taxes on larger
incomes, and high rates of taxation on estates. Yet leading members
of Congress have advocated increases in capital gains taxes, adding an
additional tax on ”high” incomes, and a return to higher estate taxes. These
proposals would hurt all higher income persons, but might be particularly
discouraging to startups,and to the expansion of smaller businesses.

I believe that smaller
businesses can competes effectively against more sluggish larger and more
established businesses without getting special privileges, such as the
President’s additional proposal to subsidize bank loans to small businesses. However,
small business does thrive much better in an environment where success is not
taxed at high rates, and where regulations and mandates do not have a
disproportionately large effect on their costs and profits.

Comments

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Many of Obama's policy proposals (not to mention the very fact that he got elected to the White House) are a testament to the ignorance of the large segment of the electorate who are too young to remember how bad things were under Jimmy Carter. Back in the late 1970s and even into the early 1980s, the government experimented with so-called "targeted job tax credits" for employers who chose to hire unemployed people. For the most part the jobs did not outlast the time period that employers had to keep the new hires on the payroll in order to earn the tax credits.

Interesting point about the relative ease with which employers in the United States can terminate workers to cover losses. Europeans and Asians certainly enjoy a more generous work environment. Not sure if I agree with your theory about workers quitting their jobs to hold out for higher wages at a later date. Most workers think in the short run since they are faced with credit card payment, mortgages and putting food on the table.

Small business not equal to innovation. US currently holding most promise land for high tech: The best technology by sectors, US rank 57% in Telecom (out of 100% with the best technology in the field), 70% in semiconductor, 87% in software, 85% in biopharmaceuticals, and 56% in clean energy. (source business week 2008 Dec). The problems are: (a) the hi tech not create enough sustainable jobs (more of bubble and bust hype). (b) current venture capital model (not say the early years of Apples and Microsoft time) flip and demand of 300% return on ipo are not the long term investment and job creation type (MBA school should take some blame). US got creative talents, but not solid investment in development and utilization, except Gov funded agencies, such as NASA. Just look who dominated the solar cell technology? Where was it invented? The long term investment of electrical hybrid car would never occur in US. The cost benefit analysis conducted by the MBAs would killed it many times more. The US business is short sighted. increase shareholder value every quarter was taught by business school all over the country. (Plus GE share were flipped every 13 days.... does not create any stable shareholders that could be interested long term value).... Unless the fundamental focus of the business changed, there is no fix. Not enough money can solve the problem. (I am sure there are already game plan in the works to take some of the cream off the small busi program... I would not surprise if many small business just pop out in time to take funding and vanished right after the funding runs out).

Many of your comments might be applicable to some version of employer tax credits, but are not applicable to President Obama's proposal given its specific design features.

For example, Obama's proposal does not provide any incentive to fire some employees and replace them with unemployed workers because: (1) the credit is based on net employment increases since a base period; (2) the base period is 2009; (3) the credit is based on any net employment increases and is not tied to hiring workers who are unemployed. Your comment is applicable to a quite different proposal, by Senators Schumer and Hatch, which is a hiring credit for the unemployed.